CHAPTER 1

INTRODUCTION TO COMPENSATION MANAGEMENT

1.1 Meaning

Compensation is the monetary benefit which is given to an employee or worker giving their
services to an organization.

Compensation includes components like salary, wages, bonuses etc. The compensation
provided helps in motivating the employees, build their career and ensure that there are
committed in achieving the company goals.

Compensation is something, most usually money, which is given to the employees of an

organization or company as payment or reparation for their service towards the organization
or because of their loss incurred due to any organizational activity.

1.2 Definition

According to Dale Yoder, “Compensation is paying people for work.”

According to Keith Davis.“Compensation is what employees receive in exchange for their

contribution to the organization

According to Edwin B. Flippo, “The function compensation is defining as adequate and

equitable remuneration of personnel for their contributions to the organizational objectives.”

1.3 Types of compensation

A. Wages:

In economics, the price paid to labour for its contribution to the process of production is
called wages.

Definitions:
“A wage may be defined as the sum of money paid under contract by an employer to
worker for services rendered.” -Benham
“Wages is the payment to labour for its assistance to production.” -A.H. Hansen
 Types of Wages:

1. Piece Wages:
Piece wages are the wages paid according to the work done by the worker. To
calculate the piece wages, the number of units produced by the worker are taken into
consideration.
2. Time Wages:
If the labourer is paid for his services according to time, it is called as time wages.
For example, if the labour is paid Rs. 35 per day, it will be termed as time wage.
3. Cash Wages:
Cash wages refer to the wages paid to the labour in terms of money. The salary paid
to a worker is an instance of cash wages.
4. Wages in Kind:
When the labourer is paid in terms of goods rather than cash, is called the wage in
kind. These types of wages are popular in rural areas.
5. Contract Wages:
Under this type, the wages are fixed in the beginning for complete work. For instance,
if a contractor is told that he will be paid Rs. 25,000 for the construction of building,
it will be termed as contract wages.

Concepts of Wages:
 Money Wages or Nominal Wages:
The total amount of money received by the labourer in the process of production is
called the money wages or nominal wages.
 Real Wages:
Real wages mean translation of money wages into real terms or in terms of
commodities and services that money can buy. They refer to the advantages of
worker’s occupation, i.e. the amount of the necessaries, comforts and luxuries of life
which the worker can command in return for his services.

B. Salary
A salary is the regular payment by an employer to an employee for employment that is
expressed either monthly or annually, but is paid most commonly on a monthly
basis, especially to white collar workers, managers, directors and professionals.
A salary employee or salaried employee is paid a fixed amount of money each month.
Their earnings are typically supplemented with paid vacations and public holidays,
healthcare insurance in country’s without universal coverage, and other benefits.
 C. Employee Benefits
 
Employee Benefits can be termed as non-cash compensation which is given to the
employee. These benefits are given to the employee apart from salaries and wages. These
are also known as fringe benefits that are offered with the intention to attract and retain
employees.
 
There are various types of employee benefits, and we’ll outline some common examples
of employee benefits.
1. Paid leave, sick leaves, and vacation days
2. Life insurance
3. Health insurance
4. Dental insurance
5. Vision insurance
6. Gym memberships or discounts
7. Wellness programs
8. Childcare benefits
9. Employee recognition programs
10. Relocation assistance
 
Significance of employee benefits
 
1. Helps to Attarached Talented Employees.
If you want to hire the top talent in the market who can perform all the duties, then in
this situation, a proper employee benefits plan will surely do the work.
 
2. Minimize employee turnaround
When you provide the benefits, it will make your employees feel better and
meaningful and thus will reduce the chance of leaving.
 
3. Maintaining a healthy workforce.
We all know that the better you feel, the better you work, so if you want an efficient
employee, you should for sure include health benefits plans, like sick leaves and
regular health checkups.
 
4. Boost employee productivity
Good employee benefits will play a part in increasing the employees’ productivity. In
addition, these benefits provide mental happiness, which leads to being more
productive.

Types of employee benefits

 
1. Life Insurance Benefit
The principal purpose of life insurance is to protect the employee’s family if he dies. All
the benefits get transferred directly to theLife insurance policy beneficiary or
beneficiaries. Generally, the beneficiaries are children, wives, or husbands.
 
2. Paid Leaves/Vacations Benefit
PTO – Part Time Off is given to the employees in the middle of working. It can come up
in the form of vacations, sick leave, and holidays.
 
3. Fringe Benefits
Fringe Benefits are a bulk of benefits given to the employees in the non-cash payments.
Also, it includes child care benefits, bonuses indirectly related to productivity, tuition
assistance, child care spending accounts.
 
4. Medical Insurance Benefit
Medical Insurance covers all the medical fees, medication fees, hospital bed fees, surgeon
fees, as well as prescription fees. It also includes the dental and optical care benefits as a
whole. Employees can also be benefited under such coverages by few organizations.
 
5. Domestic Partner Benefits
To avail of the domestic partner benefit, the employee needs to perform some formalities.
He needs to start with signing a form. Then he is requires to showcase his financial
interdependence and the unmarried domestic partnership.

6. Retirement Benefits
Retirement Benefits are generally provided to the employees in monthly pensions or
income after they end their careers. It typically falls into two categories

7. Defined Contribution Plans

Under this, an employee’s benefit is directly linked to the returns from the investment,
which most in various cases isn’t assured. However, the employers’ and the employees’
contributions are specified.
 
8. Defined Benefit Plans or Pension Plans
In this case, all investment-related risks are borne by the employer. Under this, the
benefit amount providing to the employees is predefine. The amount is based on the
salary drawn by the employee in his previous years as well as the total number of
experience he holds.
 
9. Disability Insurance Benefit
 It enables the benefit of getting the lost income from the day you are met with an
accident, leading you to stop working as well as earning. Also, it is of two types short-
term disability works immediately and is meant for short-term physical illnesses like
minor accidents or injuries.

D. Dearness Allowance (DA)

Dearness Allowance is the cost of living adjustment allowance which the government
pays to the employees of the public sector as well as pensioners of the same. DA
component of the salary applies to both employees in India and Bangladesh.

Calculation of Dearness Allowance

After the Second World War, the DA component was introduced by the government.
After 2006, the formula for calculating dearness allowance has changed and currently,
DA is calculated as follows:

 For Central Government employees:

Dearness Allowance % = ((Average of AICPI (Base Year 2001=100) for the past 12
months -115.76)/115.76)*100

 For Central public sector employees:

Dearness Allowance % = ((Average of AICPI (Base Year 2001=100) for the past 3
months -126.33)/126.33)*100

Types of Dearness Allowance

a. Industrial Dearness Allowance

Industrial dearness allowance or IDA is the allowance applicable to employees of
public sector enterprises. Recently, the government of India has increased IDA by
5% for this sector. This decision is set to benefit all board-level executives,
officers, and employees of central PSUs.
IDA for government sector enterprises is revised quarterly based on the
movement of the Consumer Price Index (CPI) to compensate for the rising
inflation in the country.

b. Variable Dearness Allowance

 VAD or Variable dearness allowance is the allowance that comes as a result of
revision every six months for central government employees. The changed new
figure that is received as a result of taking into consideration the increase or
decrease in the Consumer Price Index, CPI, is termed as Variable dearness
allowance. Based on this figure, the DA of employees is revised and rolled out.

E. Consolidated salary
Consolidated salary meaning is the amount you get without any allowances or perks it is
the permanent salary irrespective of performance criteria or target achieved etc. For
example, if your Consolidation salary is Rs15000 means you'll surely get Rs15000 and
rest above depends on your performance.

Consolidated pay sometimes refers to the full amount salary which includes both fixed
and changeable pay. Consolidated pay means the cost to the company that includes all
costs incurred by the company at the request of an employee like employers contribution
to Free house/company leased accommodation, PF, Gratuity Insurance, etc. An employee
needs to know the breakup of the benefits which are included in such a package.

F. Equity Compensation
Equity compensation is a non-cash pay an organisation can offer to its employees as
ownership in the firm. Equity compensation is provided in different forms, such as stock
options, performance shares, and restricted stock. Employees who receive equity
compensation could share the company’s profits through appreciation.

Kinds of equity compensation

a. Stock options
Companies offer stock options that provide the right to purchase shares of the
company’s stocks at a predetermined price, called exercise price. This right allows the
employees to gain control of this option after working for the company for a specific
time. When option vests, they gain the right to sell or transfer this option. This process
helps in employee retention for a longer time.

b. Non-qualified Stock Options (NSOs) and Incentive Stock Options (ISOs)

There are other additional types of equity compensation, such as NSOs and ISOs. In the
case of NSOs, employers do not have to report when they receive this option or when
its exercised. ISOs that offer special tax advantages are available only for employees,
and not non-employee directors or consultants.

c. Restricted stock
 Restricted stocks units indicate a company’s promise to pay shares based on a vesting
schedule. While this benefits the company, it does not give any ownership rights to the
employees, until the shares are earned and issued.

d. Performance shares
Performance shares are awarded to employees only when specific metrics are fulfilled.
These metrics could include return on equity, earnings per share, or the total return of
the company’s stock in relation to an index. Such shares are typically for over a multi-
year time horizon.

G. Commission
Commission refers to the compensation paid to an employee after completing a task,
which is, often, selling a certain number of products or services.
 
 Sales and marketing jobs in many industries, such as automobiles and real estate,
generally offer commission-based compensation. It can be part of the salary of an
employee or a separate form of income that is paid on a different schedule. It is
calculated based on a percentage of total sales.

H. Reward
Reward is an incentive plan to reinforce the desirable behavior of workers or employers
and in return for their service to the organization. Rewards can be monetary in the form
of salary or non monetary in the form of awards for some special services to the company
or simply giving an employee a work which he enjoys doing.
The primary objective of organizations in giving rewards is to attract, maintain and retain
efficient, high performing and motivated employees.

Types of Rewards
Intrinsic
They are incentives which satisfy an employee internally. Only money is not enough to
motivate people and it is important to make people realize their contribution to the
organization matters. That motivates employees internally.
Intrinsic incentives can be giving meaningful work to employees, giving autonomy to
employees, allowing employees to take responsibility in areas of their expertise and
provide developmental opportunities to employees
Extrinsic
They are mostly tangible incentives like pay, advancement, recognition, time off etc.
Extrinsic rewards the ones which are more sought after by employees as it can improve
the motivation and job satisfaction in the short term and addresses immediate issues.

I. Employee Remuneration
 Employee Remuneration refers to the reward or compensation given to the employees for
their work performances. Remuneration provides basic attraction to a employee to
perform job efficiently and effectively.

Methods of Employee Remuneration

 Time Rate Method: Under time rate system, remuneration is directly linked with the
time spent or devoted by an employee on the job. The employees are paid a fixed pre-
decided amount hourly, daily, weekly or monthly irrespective of their output.

It is a very simple method of remuneration. It leads to minimum wastage of resources and

lesser chances of accidents. Time Rate method leads to quality output and this method is
very beneficial to new employees as they can learn their work without any reduction in
their salaries.

 Piece Rate Method: It is a method of compensation in which remuneration is paid on the

basis of units or pieces produced by an employee. In this system emphasis is more on
quantity output rather than quality output. Under this system the determination of
employee cost per unit is not difficult because salaries differ with output.

J. Bonus
Bonus is the extra payment or financial component which is received as a reward for
doing one’s job well. Bonus usually comes along with salary of the employee. It is the
gesture of appreciation from the organization towards their employees.
This is either given during the festivals as well such as Diwali, Christmas, etc. or is part
of the salary structure of the employee.
The distribution of the bonus completely depends upon the policies of the organization.

Types of Bonus
1. Performance Bonus
This kind is given to employees based on their performance in a given period e.g.
year or quarter
2. Festival Bonus
This type is linked to some occasion or festival in the local location of operations
of the company e.g. New Year
3. Referral Bonus
Many companies have a referral program where in employees refer other
candidates to the company. If a company has a referral program, then on a
successful referral the existing employee can be given an incentive. 
4. Joining Bonus
 When a new employee joins a company, he or she can be offered a one time
joining amount. 
This is a bonus which is given at a very early stage of employee's career path in a
company as compared to other types of bonus.
5. Retention Bonus
This is given as a one time payment to retain the employee in the organization.
6. Miscellaneous
This can be given on some special event e.g. on 25th anniversary of the company,
every employee gets a smartphone. The above list consists of the common bonus
types we have in various companies. There can be very specific bonuses which a
company gives to their employees as well.

K. Incentive

Incentives can be defined as monetary or non-monetary reward offered to the employees

for contributing more efficiency. Incentive can be extra payment or something more than
the regular salary or wage. Incentive acts as a very good stimulator or motivator because
it encourages the employees to improve their efficiency level and reach the target.

The two common types of incentives are:

1. Monetary or Financial Incentives

The reward or incentive which can be calculated in terms of money is known as monetary
incentive. These incentives are offered to employees who have more physiological, social
and security need active in them. The common monetary incentives are:

a. Pay and allowances. Regular increments in salary every year and grant of allowance act
as good motivators. In some organizations pay hikes and allowances are directly linked
with the performance of the employee. To get increment and allowance employees
perform to their best ability.
b. Profits sharing. The organization offer share in the profits to the employees as a
common incentive for encouraging the employees for working efficiently. Under profits
sharing schemes generally the companies fix a percentage of profits, and if the profits
exceed that percentage then the surplus profits is distributed among the employees. It
encourages the employees to work efficiently to increase the profits of the company so
that they can get share in the profits.
c. Co-partnership/stock option. Sharing the profit does not give ownership right to the
employees. Many companies offer share in management or participation in management
along with share in profit to its employees as an incentive to get efficient working form
the employees. The co-partnership is offered by issue of shares on exceeding a fixed
target.
d. Bonus. Bonus is a onetime extra reward offered to the employee for sharing high
performance. Generally when the employees reach their target or exceed the target then
they are paid extra amount called bonus. Bonus is also given in the form of free trips to
foreign countries, paid vacations or gold etc. some companies have the scheme of
offering bonus during the festival times.
e. Commission. Commission is the common incentive offered to employees working under
sales department. Generally the sales personal get the basic salary and also with this
efforts put in by them. More orders mean more commission.
f. Suggestion system. Under suggestion system the employees are given reward if the
organization gains with the suggestion offered by the employee. For example, if an
employee suggests a cost saving technique of then extra payment is given to employee
for giving that suggestion. The amount of reward or payment given to the employee
under suggestion system depends on the gain or benefit which organization gets with that
suggestion it is a very good incentive to keep the initiative level of employees high.
g. Productivity linked with wage incentives. These are wage rate plans which offer higher
wages for more productivity. Under differential piece wage system efficient workers are
paid higher wages as compared to inefficient workers. To get higher wages workers
perform efficiently.
h. Retirement benefits. Some organizations offer retirement benefits such as pension,
provident fund, gratuity etc. to motivate people. These incentives are suitable for
employees who have security and safety need.
i. Perks/ fringe Benefits/ perquisites. If refers to special benefits such as medical facility,
free education for children, housing facility etc. these benefits are over and above salary.
These extra benefits are related with the performance of the employees.

2. Non-Monetary/Non-Financial Incentives

Money is not the only motivator, the employees who have more of esteem and self
actualization need active in them get satisfied with the non-monetary incentives only. The
incentives which cannot be calculated in terms of money are known as non-monetary
incentives. Generally people working at high job position or at high rank get satisfied
with non-monetary incentives.

The common means or ways of non-monetary incentives are:

a. Status. Status refers to rank, authority, responsibility, recognition and prestige related to

job. By offering higher status or rank in the organization managers can motivate
employees having esteem and self- actualization need active in them.
b. Organizational climate. It refers to relations between superior/ subordinates. These are
the characteristics which describe and organization. These characteristics have direct
influence over the behavior of a member. A positive approach adapted by manager
 creates better organizational climate whereas negative approach may spoil the climate,
Employees are always motivated in the healthy organizational climate.
c. Career advancement. Managers must provide promotional opportunities to employees.
Whenever there are promotional opportunities employees improve their skill and
efficiency with the hope that they will be promoted to high level. Promotion is a very big
stimulator or motivator which induces people to perform to their best level.
d. Job enrichment/ assignment of challenging job. Employees get bored by performing
routine job. They enjoy doing jobs which offer them variety and opportunity to show
their skill. By offering challenging jobs, autonomy to perform job, interesting jobs,
employees get satisfied and they are motivated. Interesting, enriched and challenging job
itself is a very good motivator or stimulator.
e. Employee’s recognition. Recognition means giving special regard or respect which
satisfies the ego of the subordinates. Ego-satisfaction is a very good motivator. Whenever
the good efforts or the positive attitudes are show by the subordinates then it must be
recognized by the superior in public or in presence of other employees. Whenever if there
is any negative attitude or mistake is done by subordinate then it should be discussed in
private by calling the employee in cabin. Examples of employee’s recognition are
congratulating employee for good performance, displaying the achievement of employee,
giving certificate of achievement, distributing mementos, gifts etc.
f. Job security. Job security means life time bonding between employees and organization.
Job security means giving permanent or confirmation letter. Job security ensures safety
and security need but it may have negative impact. Once the employees get job secured
they lose interest in job. Of example government employees do not perform efficiently as
they have no fare of losing job. Job security must be given with some terms and
conditions.
g. Employee’s participation. It means involving employee in decision making especially
when decisions are related to workers. Employees follow the decision more sincerely
when these are taken in consultation with them for example if target production is fixed
by consulting employee then he will try to achieve the target more sincerely.
h. Autonomy/ employee empowerment. It means giving more freedom to subordinates.
This empowerment develops confidence in employees. They use positive skill to prove
that they are performing to the best when freedom is given to them.

L. Social Security

Social security is the security that society furnishes through appropriate organizations
against certain risks to which its members are exposed.
 Broadly speaking the idea of social security is that “The state shall make itself
responsible for ensuring a minimum standard of material welfare to all its citizen on a
basis wide enough to cover all contingencies of life from womb to the tomb.

According to ILO “Social security is the protection which society provides for its
members through a series of public measures against the economic and social distress
resulting from sickness, maternity, employment injury, unemployment, invalidity, old age
and death. These measures are also of a great importance to a country which is on the
way of large scale industrialization as they improve employee’s morale by providing
sense of security to them again various industrial hazards.”

Definition of Social Security

“Social security is the security that the state furnishes against the risks which an
individual of small means cannot stand the risks which an individual of small means
cannot stand up by himself or even in private combination with his fellows.”
-------------Late president Mr. V.V. Giri

Methods, Scope of Social Security

a. Medical care. social security under medical care covers pregnancy confinement and its
consequences and disease which lead to a morbid condition. “The need for pre-natal and
post-natal care was emphasized. It may include practitioner care, specialist care,
provision of essential pharmaceutical and hospitalization.”
b. Sickness Benefit. Sickness includes incapability to work resulting a loss of earning.
Under this benefit worker need not be paid for three days of suspension of earnings and
the payment of benefits may be limited to 26 weeks in a year.
c. Unemployment Benefit. Under the social security benefit cover the loss of earning
during a worker’s unemployed period when he is capable and available for work but
remains unemployed because of lack of suitable employment. As per Act this benefit may
be limited to 13 weeks payment in year.
d. Employment Injury Benefit. Under Employment Injury benefit proper medical care and
periodical payment are made to injured employee as per the legal provisions of Worker’s
compensation Act. In these days industrial work is subject to different kind of
contingencies mishaps and occupational diseases which are covered under employment
injury benefit of social security.
e. Old Age Benefit. Old age benefits is applicable in India only in few states. Under this
benefit the quantum of payment depends upon on individuals working capacity during the
period before retirement.
 f. Maternity Benefit. There is complex maternity benefit Act 1961 which covers benefit
due to pregnancy. Confinement and their consequences resulting in the suspension of
earnings. There is legal provision for medical including pre-natal confident, post-natal
care and also hospitalization if required. Fixed periodical payment of three month before
birth of the child and three month after that.
g. Family Benefit. In case of death of the bread earner this cover responsibility for
maintenance of children during the entire period of children is provided.
h. Survivor’s benefit. It refers to the benefits to the affected family in form of periodical
payments to a family following the death of its bread earner and should continue during
the entire period of contingency.
i. Invalidism benefit. In fact this benefit continue till invalidism changes into old age then
old age benefit would become payable under this benefit as per ILO convention “ a
periodical payment should cover the needs of workers who suffer from any disability
arising out of sickness or accident and who are unable to engage into any gainful
activity.”

Employee Stock Ownership Plan (ESOP)

An ESOP is a defined contribution employee benefit plan that allows employees to become
owners of stock in the company they work for. It is an equity based deferred compensation plan.

Several features make ESOPs unique as compared to other employee benefit plans.
First, only an ESOP is required by law to invest primarily in the securities of the sponsoring
employer.
Second, an ESOP is unique among qualified employee benefit plans in its ability to borrow
money. As a result, "leveraged ESOPs" may be used as a technique of corporate finance.

How does ESOP work?

 The ESOP operates through a trust, setup by the company, that accepts tax deductible
contributions from the company to purchase company stock.
 The contributions made by the company are distributed to individual employee accounts
within the trust.
 The amount of stock each individual receives may vary according to pre-established
formulas based on salary, service, or position.
 The employees may "cash out" after vesting in the program or when they leave the
company. The amount they may cash out may depend on the vesting requirements.
1.4 Compensation Dimension

A brief description of the eight compensation dimensions and some of their components will
help the reader understand appreciate the complexity of a compensation system in a
modern technology.

1. Pay for Work and Performance:

 Pay for work and performance includes money that is provided in the short term
(Weekly, Monthly, and Annual bonuses/rewards) and that permits employees to
pay for and contract for the payment of desired goods and services.
 Typical components within this dimension are base pay, premium and
differential, short-term bonuses, merit pay, and certain allowances.
2. Pay for time not worked:
 Over the years, the number of hours worked per week and the number of days
worked per year have decreased.
 During the past 40 years, workers have enjoyed more days off with pay for
holidays, longer paid vacations, and paid time off for a wide variety of personal
reasons.
 These components of pay for time not worked significantly increase labor costs
and also enhance quality-of-life opportunities for most employees.
3. Loss-of –job Income Continuation:
 Job security is and always has been the primary consideration for most workers.
 They want assurance that their jobs and the income derived from working until
they are ready to retire.
 A variety of components such as unemployment insurance, supplement
unemployment benefits (SBUs), and severance pay help unemployed workers
subsist until new employment opportunities arise.
4. Disability income continuation:
 The possibility always exists that a worker will incur health or accident disability.
 Because of these disabilities, employees are frequently unable to perform their
normal assignments.
 Even so, individual and family living expenses continue, and medical, hospital,
and surgical bills create additional burdens. ü Social security, workers
compensation, sick leave, and short and long-term disability plans are examples
of components that provide funds for employees who are unable to work for
health-related reasons.
5. Deferred Income:
 Most employees depends on some kind of employer-provided program for
income continuation after retirement. These programs are two basic reasons.
 First, most employees do not have sufficient savings at retirement to continue the
lifestyles they enjoyed while working. Various kind of programs, such as Social
Security, employer provided pension plans, savings and thrift plans, annuities,
and supplemental income plans provide income after retirement.
  Second, Tax law and regulations make deferred income plans more appealing to
many employees
6. Spouse (Family) Income Continuation:
 Most employees with family obligations are concerned with what might happen if
they are no longer able to provide money that will enable their families to
maintain a particular standers of living.
 Certain plans are designed to provide dependents with income when an
employee dies or is unable to work because of total and permanent disability.
 Specific features within life insurance, pension plans, Social; Security, Workers’
compensation, and other related plans provide income for the families of
employees when these conditions arise.
7. Health, Accident, and Liability Protection:
 When a health problem occurs employees must be concerned not only with
income continuation, but also with payment for the goods and services required
in overcoming the illness or disability.
 Organizations provide a wide variety of insurance plans to assist in paying for
this goods and services.
 In recent years, the cost of medical-related goods and services has increased at
a greater rate than almost other goods and service desired or required by
employees.
8. Income Equivalent Payment:
 A final set of compensation components may be grouped under the title of
income equivalent payments.
 Many of these components are frequently called perquisites or Perks.
 Employee usually find them highly desirable, and both employers and employees
find certain tax benefits in them.
 Some parks are tax free to employees and tax deductible to employers.
 In recent years, the Internal Revenue Service (IRS) has required that employer
costs for specific portion of certain parks be considered earned income to
employees.

1.5 Non-compensation System

The other part of the reward system consists of non-compensation rewards.

 These rewards are much more difficult to classify and their components are far more
complex than is the case for compensation rewards and components.
 In fact, Any activity that has an impact on the intellectual, emotional, and physical well-
being of the employee and is not specifically covered by the compensation system is
part of the non-compensation reward system.
 An in-depth analysis of the seven non-compensation dimensions identified in rewards
these are;
1. Enhance Dignity and Satisfaction from work performed:
 Possibly the least costly and one of the most powerful rewards an
organization can offer to an employee is to recognize the person as a useful
and valuable contributor.
 This kind of recognition leads to employee feelings of self-worth and pride in
making a contribution.
 Every compensation and non compensation reward component should carry
with it the message, “ We need you and appreciate your efforts. ”

2. Enhance psychological Health, Intellectual Growth, and Emotional Maturity:

 Considering the number of hours a person spends on the job, on travel to and
from the work site, and off the job in attempting to resolve job-related
problems, work obviously has a great effect on the health of employees.
 Health related problems frequently receive minimal attention until a serious
problem occurs.
 Once this happens, however, it overrides all other employee concerns and
activities.
 Modern health practices recognize the direct relationship between the
physiological health and intellectual and emotional well-being of each
individual.
 Provision of safe equipment a work environment that is as risk free as
possible; minimization of noxious fumes; avoidance of extreme heat, cold,
and humidity conditions, and elimination of contract with radiation,
carcinogens and other disease related materials and substances-these
conditions are expected by all employees.
 As important as these physical conditions are more and more attention is
being focused on the emotional strains that result from the extreme
specialization of work assignments and the complex interactions caused by
these specialization.
 Although these universal problems are almost impossible to overcome,
management can recognize their existence and can take action to limit their
negative influence on the performance of each employee.
3. Promote constructive Social Relationships with Coworkers.
 An old adage states that, “ One man is no man. ” Although there are constant
reminders of what one dedicated person can achieve, there are even more
reminders that one human alone is weak.
 In this world of extreme specialization, people need and rely on other people
more than ever.
 A workplace environment where trust, fellowship, loyalty, and love emanate
from the top level of management to the lowest level of the organization
promotes the kinds of social interaction most people need in order to thrive.
 The move toward team-based operations is an example of what
organizations are doing to improve social interactions among employees
4. Design Jobs That Require Adequate Attention and Effort:
 Specific attention has been focused on scientific management efforts to
specialize work assignments that were developed in the last quarter of the
nineteenth centaury.
 Many employees soon become bored and dissatisfied. Work-related anxieties
and frustration produced employee behavior that led to declining
performance.
 Employee turnover, absenteeism, tardiness, minimal concern for quality or
productivity, waste of physical resources, and even theft and malicious
damage were behaviors attributed to unacceptable workplace and job design.
 Managers are being taught to instruct workers to do their jobs and then to
leave them alone to perform their assignments in their own ways.
 This does not mean that managers must abdicate supervisory
responsibilities. Rather, they must learn to recognize when to provide needed
support, When to tell employees what they are doing right, and when to assist
them in correcting their errors.
5. Allocate Sufficient Resource to Perform Work assignments:
 Requiring employees to perform assignments for which they have neither the
knowledge nor the skills opens the door or for problems.
 Not only is the organization likely to suffer because of outcome failures, but
employee job-related interest and satisfaction are apt to break down because
of the likelihood or inevitability of failure.
 To make work a satisfying, even exhilarating experience, employees must not
be placed in a no-win situation.
 This doesn’t mean that an employee should not be expected to stretch and
put forth sufficient effort to meet workplace obligations.
6. Grant Sufficient Control over the Job to Meet Personal Demands:
 From the 1950 s to the present time, behavioral scientists have discussed the
need to grant employees greater opportunity to participate in organizational
decision-making process.
 A few people in every organization want to tell top management how to run
the organization. Between these two extremes is a wide variety of demands
for a greater voice in determining how to perform assignments.
7. Offer Supportive Leadership and Management:
 This dimension is difficult to separate from all other non-compensation
rewards, but it is so important that is must be recognized as a unique
dimension of the non compensation rewards and not just a component of the
other factors.
 Employee faith and trust in management assist in establishing a workplace
environment where job security becomes accepted, where social interaction
thrives, and where work satisfaction is possible.
  Supportive leadership is demonstrated in many ways: skill and inters in
coaching and counseling. Praise for a job done, and constructive feedback
leading to improvement of job performance.
 The selection, training, and promotion of individuals who will later become
effective leaders and managers are the cost components of this dimension.

1.6 3P Compensation Concept:

Management of any organization considers 3 parameters while deciding salary and incentives
1. Pay for position
2. Pay for person
3. Pay for performance
This program helps to establish guidelines for
1. An equitable grading structure
2. Determining capability requirements
3. Creating incentives
4. Long term reward plans
1. Pay for position:
Broad banding:
 Through broad branding the traditional structure pay grades determine
through job evaluation which are replaced by fewer and wider bands and a
grading structure is created.
 It is a compensation technique that reduces many different compensation
categories to several compensation bands. A banding procedure takes place
when jobs grouped together by common characteristics.
 On recruitment or promotion employee compensation may be set appropriate
to employee’s qualification, education, training and experience
 Employee typically progress up through the broad band if their performance
ratings are good rather than progressing up through a grade by steps based on
the time.
2. Pay for Person:
 Pay for person takes into account a person’s capabilities and experience in
setting a pay level that is both equitable and competitive.
 It also considers the market demand of a person’s unique skills and
experience.
 Pay for person is associated with competency based pay.
3. Pay for performance:
An individual performance is managed thru a performance contract which consists of
1. Clarification of the role.
2. Setting up the objectives
 3. Review of performance
As an outcome a measure of performance at the corporate individual level becomes
the bases for setting the performance pay.

1.7 How Does Compensation Affect Employee Retention?

Compensation can have a direct impact on employee retention. While employers may use
employee incentives and monetary rewards to retain employees, there are ways to
complement compensation that have a much greater impact. Based on the type of
compensation, along with the terms and conditions of an employee compensation package,
an employer can boost employee retention.

Employee Retention
Employee retention refers to the number or percentage of employees your organization
retains. The term retention is often used in discussions about employee turnover.
The differences between retention and turnover are subtly related;

However, retention is more about improving satisfaction of current employees by providing

challenges, development opportunities and incentives such as retention bonuses and
compensation that encourages your most talented employees to stay with the company.

Turnover, on the other hand, is inevitable within any organization. Turnover occurs both
involuntarily and voluntarily for a number of reasons. Attempts to reverse turnover using
retention strategy that includes compensation is ill-advised, not to mention
counterproductive.

Employees looking voluntarily to make a change want to continue their career with a
company that offers promotion and development opportunities, a collegial work
environment and a leadership team that's openly appreciative of its human capital.
Compensation and benefits may be important factors in the decision to look for
employment elsewhere; however, many reports indicate compensation is low on the list of
priorities in looking for another position.

Employees have an intrinsic need for respect, motivation and challenging work, which are
compelling reasons for seeking employment elsewhere. Employers who consider
compensation as part of the strategy for employee retention are headed in the right
direction, but are looking at just one half of the equation. Compensation coupled with
better opportunities to develop employee skills is a more complete way of formulating an
effective retention strategy.
 Tying Compensation to Retention
One of the most effective ways compensation can have a positive impact on employee
retention is to construct an employee development plan that promises employees career
track opportunities with the company.

Being on an upward career track should come with corresponding salary and merit
increases. In addition, performance-based bonuses motivate employees in terms of aligning
their individual goals with company goals.

Implementing incentives such as stock options, profit sharing and spot rewards are other
ways compensation affects retention. These forms of compensation demonstrate how
critical employee performance is to the organization's overall profitability.

Spot rewards are usually not as lucrative; however, they provide immediate recognition,
reward and compensation when company leadership observes an employee performing
superior work. Appreciation is key to employee retention, and if compensation is a part of
recognition, then compensation is likely to increase employee retention.

1.8 Challenges of Compensation Management

Even the most rational methods of determining pay must be tempered by good judgment
when challenges arise.
The implications of these demands may cause analysts to make further adjustments to
compensation.
1. Strategic Objectives
Compensation management is not limited to internal and external equity. It also can be
used to further an employer’s strategy. Employee compensation might have been initially
anchored by the relative worth of jobs and the prevailing wage rates in the local market.
2. Prevailing Wage Rates
Market forces may cause some jobs to be paid more than their relative worth.
Demographic shifts and relative supply and demand relationships affect compensation.
3. Union Power
When unions represent a portion of the workforce, they may obtain wage rates that are
out of proportion to the relative worth of the jobs.
Unions may also limit management’s flexibility in administering merit increases since
unions often argue for raises based on seniority and are applied across the board equally.
4. Government Constraints
The government sets minimum wage, overtime pay, equal pay, child labor, and record-
keeping requirements. The minimum-wage and overtime provisions require employers
to pay at least a minimum hourly rate regardless of the job’s worth.
 5. Comparable Worth and Equal Pay
Beyond “equal pay for equal work” is the idea of “comparable pay for comparable work”
called comparable worth. It requires employers to pay equal wages for jobs of
comparable values.
Comparable worth is used to eliminate the historical gap between the incomes of men and
women.
6. Compensation Strategies and Adjustments
Most organizations have compensation strategies and policies that cause wages and
salaries to be adjusted.
A common strategy is to give nonunion workers the same raises given to unionized
employees; this is often done to prevent further unionization.
7. International Compensation Challenges
The globalization of business affects compensation management.
Compensation analysts must focus not only on equity but on competitiveness too. The
growing globalization of business also means a greater movement of employees among
countries.
As employees are relocated, compensation specialists are challenged to make fair
adjustments to the employee and the company while keeping competitiveness in
mind.Monetary
8. Productivity and costs
Regardless of the company or social policies, employers must make a profit to survive.
Without profits, they cannot attract enough investors to remain competitive.
Therefore, a company cannot pay its workers more than the workers give back to the firm
through their productivity. The company needs some creative techniques for
compensation.

1.9 International Compensation Management

Compensation management can be defined as the provisions of monetary and non-monetary
rewards, including base salary, benefits, perquisites, long and short-term incentives, valued
by employees in accordance with their relative contributions to MNC performance. Its broad
HRM purpose is to attract, retain and motivate that personnel required throughout the MNC
currently and in the future.
Job evaluation is the means by which internal relatives and compensable factors, those
elements an individual's work role in the MNC and contribute to its performance are
determined.

Objectives of International Compensation Management

1. Recruitment and Retention of suitable Employees
MNCs design and practice compensation and benefits in order to attract, and retain
suitable employees in terms of job efficiency and cultural adaptability.
2. Consistency and Equity
MNCs design the salary and benefits package to secure consistency between pay and
performance and equity among employees of different nationalities and categories, and
employees of subsidiaries and parent company.
3. Facilitate Mobility
MNCs design pay package in order to enable the employees to move from the parent
company to foreign subsidiaries and from one foreign subsidiary to another foreign
subsidiary.
4. Adaptability to Foreign Cultures and Environment
MNCs design pay package that motivates employees and his/her family members to
willingly adapt to the cultures and environment of the foreign countries. For example,
providing comfortable housing, highly reliable medical facilities, security facilities
against odds and international standards schooling facilities encourage employee's family
members to adapt to the foreign country cultures and environment and allow the
employee to concentrate on the job.
5. Organisational performance
MNCs pay package should work as motivator to enhance employee job performance,
learning latest skills and contribute to the enhancement of organisational performance. In
fact, performance based pay package enhances organizational performance.

1.10 Importance of International Compensations

2. Attracting and Retaining Personnel
Most to attract and retain staff in the areas where the multinational has the greatest needs
and opportunities, hence must be competitive and recognize factors such as the incentive
for Foreign Services, tax equalization, and reimbursement for reasonable costs.
3. Optimizing Cost of Compensation
It is to facilitate the transfer of International employees in the most cost-effective manner
for the firm. Compensation management aims at optimizing the cost of compensation by
establishing some kind of linkage with performance and compensation. It is not necessary
that a higher level of wages and salaries will bring higher performance automatically but
depends on the kind of linkage that is established between performance and wages and
salaries.
4. Consistency in Compensation
It means to be consistent with the overall strategy, structure and business needs of the
multinational. Compensation management tries to achieve consistency-both internal and
external in compensating employees. Internal consistency involves payment of the basis
of criticality of jobs and employees' performance on jobs. Thus higher compensation is
attached to higher-level jobs. Similarly, higher compensation attached to higher
performers in the same job. External consistency involves similar compensation for a job
in all organizations. Though there are many factors involved in the determination of wage
and salary structure for a job in an organization which may result into some kind of
 disparity in the compensation of a particular job as compared to other organization,
compensation management tries to reduce this disparity.
5. Motivating Personnel
Compensation management aims at motivating personnel for higher productivity.
Monetary compensation has its own limitations in motivating people for superior
performance.

Major Components in an International Compensation Package

International Compensation is an internal rate of return (monetary or non monetary
rewards / package) including base salary, benefits, perquisites and long term & short term
incentives that valued by employee's in accordance with their relative contributions to
performance towards achieving the desired goal of an organization.

The following are the major components of an international compensation package.

1. Base Salary
This term has a slightly different meaning in an international context than in a domestic
one. In the latter case, it denotes the amount of cash compensation that serves as a
benchmark for other compensation elements like bonus, social benefits. For the
expatriate, it denotes the main component of a package of allowances directly related to
the base salary and the basis for in-service benefits and pension contributions. Base salary
actually forms the foundation block of the international compensation.

2. Foreign Service Inducement Premium

This is a component of the total compensation package given to employees to encourage
them to take up foreign assignments. This is with the aim to compensate them for the
possible hardships they may face while being overseas. In this context, the definition of
hardship, the eligibility criteria for premium and the amount and timing of this payment
are to be carefully considered. Such payments are normally made in the form of a
percentage of the salary and they vary depending upon the tenure and content of the
assignment. In addition, sometimes other differentials may be considered. For instance: if
a host country's work week is longer that of the home country, a differential payment
may be made in lieu of overtime.

3. Allowances
One of the most common kinds of allowance internationally is the Cost of Living
Allowance (COLA). It typically involves a payment to compensate for the differences in
the cost of living between the two countries resulting in an eventual difference in the
expenditure made. Atypical example is to compensate for the inflation differential.
COLA also includes payments for housing and other utilities, and also personal income
tax.
Other major allowances that are often made are:
 • Home leave allowance
• Education allowance
• Relocation allowance
• Spouse assistance (compensates for the loss of income due to spouse losing their
job)
Thus, multinationals normally pay these allowances to encourage employees to take up
international assignments to make sure that they are comfortable in the host country in
comparison to the parent country.

4. Benefits
The aspect of benefits is often very complicated to deal with. For instance, pension plans
normally differ from country to country due to difference in national practices. Thus all
these and other benefits (medical coverage, social security) are difficult to imitate across
countries.
Thus, firms need to address a number of issues when considering what benefits to give
and how to give them. However, the crucial issue that remains to be dealt with is whether
the expatriates should be covered under the home country benefit programmes or the
ones of the host country. As a matter of fact, most US officials are covered by their home
country benefit programmes.
Other kinds of benefits that are offered are:
• Vacation and special leaves
• Rest and rehabilitation leaves
• Emergency provisions like death or illness in the family
These benefits, however, depend on the host country regulations.
5. Incentives
In recent years some MNC have been designing special incentives programmes for
keeping expatriate motivated. In the process a growing number of firms have dropped the
ongoing premium for overseas assignment and replaced it with on time lump-sum
premium. The lump-sum payment has at least three advantages. First expatriates realize
that they are paid this only once and that too when they accept an overseas assignment.
So the payment tends to retain its motivational value. Second, costs to the company are
less because there is only one payment and no future financial commitment. This is so
because incentive is separate payment, distinguishable for a regular pay and it is more
readily for saving or spending.

6. Taxes
The final component of the expatriate's compensation relates to taxes.
MNCs generally select one of the following approaches to handle international taxation.
• Tax equalization: Firm withhold an amount equal to the home country tax
obligation of the expatriate and pay all taxes in the host country.
 • Tax Protection: The employee pays up to the amount of taxes he or she would
pay on remuneration in the home country. In such a situation, The employee is
entitled to any windfall received if total taxes are less in the foreign country then
in the home country.

7. Long Term Benefits or Stock Benefits

The most common long term benefits offered to employees of MNCs are Employee
Stock Option Schemes (ESOS). Traditionally ESOS were used as means to reward top
management or key people of the MNCs.

Some of the commonly used stock option schemes are:

• Employee Stock Option Plan (ESOP): A certain nos. of shares are reserved for
purchase and issuance to key employees. Such shares serve as incentive for
employees to build long term value for the company.
• Restricted Stock Unit (RSU): This is a plan established by a company, wherein
units of stocks are provided with restrictions on when they can be exercised. It is
usually issued as partial compensation for employees. The restrictions generally
lifts in 3-5 years when the stock vests.
• Employee Stock Purchase Plan (ESPP): This is a plan wherein the company
sells shares to its employees usually, at a discount. Importantly, the company
deducts the purchase price of these shares every month from the employee's
salary.
Hence, the primary objective for providing stock options is to reward and improve
employee's performance and /or attract / retain critical talent in the Organization.

1.11 Factors Affecting Employee Compensation

The Compensation is the monetary and non-monetary rewards given to the

employees in return for their work done for the organization. Basically, the
compensation is in the form of salaries and wages. There are several internal and
external factors affecting employee compensation

1. Internal factors

The internal factors exist within the organization and influence the pay structure of the
company. These are as follows:

(i) Ability to Pay- The prosperous or big companies can pay higher compensation as
compared to the competing firms whereas the smaller companies can afford to maintain
their pay scale up to the level of competing firm or sometimes even below the industry
standards.
(ii) Business Strategy- The organization’s strategy also influences the employee
compensation. In case the company wants the skilled workers, so as to outshine the
competitor, will offer more pay as compared to the others. Whereas, if the company
wants to go smooth and is managing with the available workers, will give relatively less
pay or equivalent to what others are paying.

(iii) Job Evaluation and Performance Appraisal- The job evaluation helps to have
a satisfactory differential pays for the different jobs. The performance Appraisal helps an
employee to earn extra on the basis of his performance.

(iv) Employee- The employee or a worker himself influences the compensation in

one of the following ways.

 Performance- The better performance fetches more pay to the employee, and
thus with the increased compensation, they get motivated and perform their job
more efficiently.
 Experience- As the employee devotes his years in the organization, expects to
get an increased pay for his experience.
 Potential- The potential is worthless if it gets unnoticed. Therefore, companies
do pay extra to the employees having better potential as compared to others.

2. External Factors

The factors that exist out of the organization but do affect the employee compensation in
one or the other way

These factors are as follows:

(i) Labor Market- The demand for and supply of labor also influences the employee
compensation. The low wage is given, in case, the demand is less than the supply of labor.
On the other hand, high pay is fixed, in case, the demand is more than the supply of labor.

(ii) Going Rate- The compensation is decided on the basis of the rate that is prevailing in
the industry, i.e. the amount the other firms are paying for the same kind of work.
(iii) Productivity- The compensation increases with the increase in the production.
Thus, to earn more, the workers need to work on their efficiencies, that can be improved by
way of factors which are beyond their control. The introduction of new technology, new
methods, better management techniques are some of the factors that may result in the better
employee performance, thereby resulting in the enhanced productivity.
 (iv) Cost of Living- The cost of living index also influences the employee
compensation, in a way, that with the increase or fall in the general price level and the
consumer price index, the wage or salary is to be varied accordingly.

(v) Labor Unions- The powerful labor unions influence the compensation plan of the
company. The labor unions are generally formed in the case, where the demand is more,
and the labor supply is less or is involved in the dangerous work and, therefore, demands
more money for endangering their lives. The non-unionized companies or factories enjoy
more freedom with respect to the fixation of the compensation plan.

(vi) Labor laws- There are several laws passed by the Government to safeguard the
workers from the exploitation of employers. The payment of wages Act 1936, The
Minimum wages act 1948, The payment of Bonus Act 1965, Equal Remuneration Act
1976, Payment of Gratuity Act 1972 are some of the acts passed in the welfare of the labor,
and all the employers must abide by these.

Thus, there are several internal and external factors that decide the amount of compensation
to be given to the workers for the amount of work done by them.

1.12 Compensation policy

The compensation policy describes the details of the compensation components in the
organization, how they are used and the conditions for the employees as the
compensation component can be applied in their specific situation.
Each organization uses many compensation components and they have to be described.
The compensation policy provides the basic explanation of the compensation component,
how it is calculated, who is eligible for the usage and the approval procedure.
The compensation policy belongs to most read and discussed internal policies of the
organization as it drives the salaries of the individual employees. Each employee is
interested in the structure of the salary and the potential total cash achievable in the
organization. The compensation policy is the main tool to find out the details about the
compensation components and the way, how to achieve the highest total cash.

Important in the compensation policy

The compensation policy has to be transparent and it has to provide just the only way of
the interpretation.  It is extremely important, the employees and managers are not unsure
about the compensation component and they understand clearly, what conditions are
applied for the approval of the specific compensation component.
The transparent compensation policy supports the high performance corporate culture
organization as the employees understand, what behavior and performance levels are
expected to be eligible for the specific compensation component and it drives the
behavior and performance specifically the right way for the organization.
The policy has to cover all the compensation components, which are used in the
organization and affects large populations. The exceptional managerial component tools
can be referenced from the general compensation policy, but they should not stay hidden.
The employees cannot trust the compensation policy, which does not mention all the
compensation components.